Netflix stock hit an all-time high one day before the earnings. The rally continued following the earnings announcement on January 18th, when the stock price rose by over 10%. The international subscriber base increased at a rapid pace once again, while growth in the domestic subscriber base showed signs of fatigue. We believe that Netflix’s overall subscriber base will continue to grow in the coming years due to its international expansion efforts, specifically as it targets the untapped and under-served Asia-Pacific region. However, growth rate for domestic subscribers is likely to slow down, as the market is increasingly mature.

While Netflix’s international streaming subscription vertical makes up only 30% of Netflix’s estimated value, Netflix’s international subscriber growth has been thus far very strong. We believe that the international subscriptions will continue to grow at a robust pace in the near foreseeable future as the company has a presence in 190 countries. Netflix delivered an excellent performance in the international segment this quarter as its subscriber base grew by a record 5.12 million customers, exceeding its forecast of 3.75 million. The company expects the growth in subscribers to continue and hopes to add 3.7 million subscribers in the international markets for Q1 2017. We believe that Netflix can cross 80 million international subscribers by the end of our forecast period as most of the regions that Netflix has expanded to are under-served.

Domestic Subscriber Growth Shows Signs Of Slowing Down

Netflix’s first mover advantage has helped the company to establish itself as the incumbent in the video on demand industry. However, the current online streaming landscape is becoming increasingly competitive. Many content providers such as Dish Network, Sony, HBO, CBS, Comcast etc., have thrown their hat into the streaming ring and incumbent players such as Hulu and Amazon Prime have ramped up investment in order to improve the quality of their content. Despite, the competition, Netflix was able to add 1.93 million members in the quarter, exceeding its forecast of 1.45 million. However, considering that the limits to the US market, the company will find it increasingly difficult to add new subscribers at a rapid pace. We believe that Netflix will continue to add new users throughout our forecast period on the strength of its original content and library, which allow for binge watching.

Steady Improvement In Margins

Netflix’s international streaming margins have improved steadily over the years, climbing from -127% in 2012 to -7% by the end of Q4 2016.However, the margins have been put under pressure this year because of unfavorable currency movements and the additional costs undertaken due to aggressive expansion. The company expects it to be around -1.5 % for the next three months. We believe that Netflix’s international segment will start to break even by 2017 and will start having positive contribution margin from 2018 onward. It will then stabilize at around 30% by the end of our forecast period. Nevertheless, its contribution margins for the U.S. streaming services were robust at 38.2% in Q4 and are expected to improve to 41.3% by the end of Q1 2017. As a result, Netflix’s overall margins have been around a 4% annual operating margin for the past two years. The company is targeting about 7% for the full year 2017 based on current F/X rates.